2.3.2: The role of public finance in the Chinese social security system: EU Experiences

Transcription

1 2.3.2: The role of public finance in the Chinese social security system: EU Experiences Final 18 June 2018 Dr. Mel Cousins, Trinity College, Dublin, Ireland EU-China

2 Contents Abbreviations... 3 Introduction... 4 Funding of social protection in the EU... 5 Current levels and sources of social protection funding... 5 Social security fund debt... 7 The role of public finance... 8 Historical background... 8 Overview... 8 Pre-subsidising social funds... 9 Subsidies to specific groups General subsidies Post-subsidising Deficit Targeted Subsiding a minimum benefit/pension Funding transitional costs Reserve Funds Discussion Studies and evaluations Subsidising contributions Minimum pensions Subsidising deficits Summary and Discussion Summary of approaches Pros and cons of different approaches Pros and cons of funding sources Pros and cons of subsidy approaches References Annex 1: Public authorities participation in financing social protection schemes (MISSOC) EU-China / 2

3 Abbreviations CADES ESSPROS EU MISSOC NPRF OECD SOCX SPC Caisse d amortissement de la dette sociale [French Social Security Debt Fund] European System of Integrated Social Protection Statistics European Union Mutual Information System on Social Protection National Pension Reserve Fund Organisation for Economic Co-operation and Development Social expenditure database Social Protection Committee (EU) EU-China / 3

4 Introduction This report forms part of Topic The role of public finance and enterprise annuities funds in the Chinese social security system. It focuses on the issue of the role of public finance. As set out in the terms of reference, the report is addressed to the issue of how to define the responsibility of public finance in relation to a subsidy for social security funds: that is whether the subsidies should be used ex-ante as a contribution to the social insurance fund or should be used ex-post to cover any expenditure deficit. This report provides examples of EU practice to help inform the future development of policy recommendations for the Chinese situation. It also looks at the limited studies available on this issue including studies from other relevant countries. In general, as identified in the terms of reference, EU practice varies very widely on this issue and the approach which has been adopted in EU member states is not simply an outcome of technical analysis but is also a result of political considerations and compromises. The paper maps the different methods used by EU member countries to subsidize social insurance and pension funds with tax revenues; collects time series data on such subsidies and their relevance, insofar as possible, analyses their historical origin and rational, while providing an evaluation of their impacts, relative advantages and disadvantages. In order to put the role of public finance in context, we first (section 1) outline the overall approach of EU member states to funding social protection including both social insurance and contributory benefits. In section 2, we look more specifically at the role of public finance in supporting social insurance funds in EU countries. Finally, section 3 discusses the issues raised and the advantages and disadvantages if different approaches. Annex 1 sets out further details (based on MISSOC) as to the role of public authorities in funding social protection schemes in selected EU countries. However, readers should be aware that the data provided by MISSOC focusses mainly on those circumstances where the member state provides an explicit subsidy to the social insurance system and may not include all examples of where the state provides support (implicit or explicit) to social security costs. 1 1 For example, the data for Ireland indicates that Ireland provides a subsidy to meet any social insurance deficits not covered by contributions from employers and employees. However, it does not indicate that Ireland also generally excludes low paid workers from social insurance costs and that it provides credited contributions to formerly insured persons during periods of, for example, unemployment or illness. Ireland also provides assistance to parents (de facto mothers) to qualify for old age pensions. These measures are not explicitly funded by the state (or indeed by anyone) but given that the social insurance fund is normally in deficit and that the state covers the costs of this deficit, they are de facto funded by the Irish public finances. No estimate of the costs involved appears to be available. EU-China / 4

5 Funding of social protection in the EU In this section we outline details about the level of social protection spending in EU countries, the sources of funding (social contributions versus general government contributions) and the level of social security fund debt. Current levels and sources of social protection funding In 2015 (most recent data), EU countries spent on average 29% of GDP on social protection (all data comes from Eurostat ESSPROS unless otherwise indicated). 2 The EU average hides major disparities between Member States. In 2015, social protection expenditure represented at least 30% of GDP in France (34%), Denmark and Finland (both 32%), Belgium, the Netherlands, Austria and Italy (all 30%). In contrast, social protection expenditure stood below 20% of GDP in Romania and Latvia (both 15%), Lithuania and Estonia (both 16%), Ireland (17%), Malta, Bulgaria and Slovakia (all 18%) as well as in the Czech Republic (19%). Further details are set out in the table below: 2 Expenditure on social protection contains: Social benefits, which consist of transfers, in cash or in kind, to households and individuals to relieve them of the burden of a defined set of risks or needs; Administration costs, which represent the costs charged to the scheme for its management and administration; Other expenditure, which consist of miscellaneous expenditure by social protection schemes (payment of property income and other). EU-China / 5

6 In 2015, the two main sources of funding of social protection at EU level were social contributions, making up 54% of total receipts, and general government contributions from taxes at 43%. Again, however, the EU average hides a wide variation in approach between different countries. One group of countries (mainly central or eastern European) derive 60% or more of their social protection receipts from social contributions. These range from Estonia (79%) to Belgium (60%) and include France and the Netherlands. In contrast, a number of countries including Nordic countries (Denmark, Finland, Sweden), 3 Ireland, Romania and the UK receive less than 50% of their receipts from social contributions. Denmark which relies heavily on public finance is an outlier with only 18% of social protection receipts coming from social contributions. Finally, a number of countries (mainly southern European) are around the average including Greece (55%), Italy (50%) and Spain (54%). This data refers to funding for the total social protection system including non-contributory benefits and, therefore, it does not indicate the extent to which states fund social insurance schemes. Indeed there are significant variations in the extent to which states rely on means-tested as opposed to contributory or other non-contributory but non-means-tested benefits. While ESSPROS does not readily provide comparisons of the extent to which countries rely on meanstested benefits in terms of % of total social protection expenditure, the EU Social Protection Committee (2015) carried out a special analysis of this data to look at the extent to which countries relied on non-means-tested (including contributory) as opposed to means-tested benefits. Overall, the EU28 relied heavily on non-means-tested benefits (89.2%) with only (10.8%) being spent on means-tested benefits. The countries which relied most heavily on non-meanstested benefits (c.95% or more) included Belgium, Bulgaria, Czech Republic, Denmark, the Baltic countries, Hungary, Poland, Romania, Slovakia, Finland and Sweden. Conversely, those which relied most heavily on means-tested benefits were Ireland (27.6%), Spain (16.4%), Netherlands (15.4%), and the UK (14.4%). Comparative data on income-tested benefits are also available from the OECD SOCX (2014) which covers many EU countries. 4 This also shows that countries such as Ireland (36.5% of total expenditure) and the UK (26%) rely heavily on means-tested benefits. 5 Thus, some of the countries which rely heavily (in comparative terms) on pubic finance to fund their social protection systems do so because their system involves a greater reliance on meanstested benefits (e.g. Ireland and the UK). Looking at countries in terms of how much they spend on social protection (compared to the EU average) and how much they rely on social contributions we find that 1) some countries spend above average and rely more on social contributions (e.g. France) 2) some spend above average but rely heavily on public finance (e.g. Denmark) 3) some spend about average and rely at about average on social contributions (Italy) 3 Norway (not an EU member state) would also fall into this group. 4 Income-tested benefits are defined as those benefits that aimed to prevent household income to fall below a certain level and for which eligibility and entitlements are conditional on the recipient's current income, and assets in the case of means-testing 5 Netherlands spends 12% on means-tested benefits but OECD data shows Denmark as spending less than 1% which suggests that OECD and EUROSTAT are using different classifications of Danish benefits. The OECD approach would appear to be correct as most studies would not categorise the Danish social protection system as relying on meanstested benefits. EU-China / 6

7 4) some spend below average but rely heavily on social contributions (Czech Republic); and 5) some spend below average and rely on public finance (Ireland). Social protection spending and financing in EU countries, Spending/ Funding Above average social contributions Above average public finance Above average spending Average Below average spending France Austria, Belgium Czech Republic, Estonia Mixed - Italy Spain Denmark, Finland Sweden, UK Ireland, Romania As can be seen, EU member states adopt a very wide range combination of different approaches. Of course, EU and OECD states also use the tax system in various ways to subsidise social protection by, for aplenty, giving tax incentives for people to contribute to pensions or more favourably tax treatment to pension income (see OECD, 2014). However, these type of tax subsidies fall outside the current study which focusses on direct expenditure subsidies to the pension system. In the next section we look in more detail at the approaches adopted by different countries to support social insurance expenditure. Social security fund debt The impact of social security funds on the general government debt in most EU countries is relatively small: contributions of less than 5% of total general government debt were recorded in most countries (see Table A1). However, three countries had higher ratios of debt for social security funds: Lithuania (20.3%), France (10.3%) and the Netherlands (6.6%). 6 We provide some examples rather than trying to include all 28 countries. EU-China / 7

8 The role of public finance Historical background The UK Beveridge Report (1942) was very influential in a range of countries in its approach to social security. Beveridge strongly supported the social insurance (contributory) approach and recommended that this should form the basis of a reformed UK social security system. He recommended that all citizens of working age would pay contributions and that benefits (without a means test) would be paid from a Social Insurance Fund built up by contributions from the insured persons, from their employers, if any, and from the State. 7 This, as Beveridge acknowledged, was a continuance of the tripartite scheme of contributions established in the UK in 1911 which included a contribution from the National Exchequer out of general taxation. The employer and employee contributions proposed in the report were intended initially to cover twothirds of the cost of unemployment and five-sixths of the cost of retirement pensions and other benefits with the remainder to be provided by government. Beveridge envisaged that the government share would rise as the scheme matured. However, no specific justification of these proportions is advanced and the approach arrived at appears more pragmatic than principled. In any case, significant changes were made in the details of the proposals when a unified social security scheme was introduced in Britain after World War II. Thus, even in the case of this classic report, the precise justification of the objective and level of public subsidy remains somewhat unclear and the final outcome appears to be largely based on policy legacies and political compromises (see Baldwin, 1992). However, the logic of Beveridge s approach (again probably based on the existing practice) was that the government s role was to subsidise the deficit in contributions and this remains the approach of the UK scheme today. Many continental European countries (such as France and Germany) adopted a Bismarckian approach to social protection, again relying heavily on social insurance but with benefit levels more closely related to social insurance contributions. It is not possible in this report to examine the origins of subsidies in other EU countries but all the evidence would suggest that these have developed over time based on compromise and policy legacies. In its study of matching contributions (one method of subsiding social insurance costs the World Bank (2013) noted that countries were rarely explicit about the objectives of a policy intervention and even less specific regarding how to measure outcomes. The same point could be made in relation to most aspects of EU countries approaches to subsiding pensions and social insurance funds. Decision makers are rarely explicit about what they are trying to achieve and, in many cases, the ultimate approach arrived at is a political compromise between different views. Overview As we have seen in the previous section, EU countries adopt very different approaches in terms of the amount they spend on social protection and how they fund this. In this chapter, we look in 7 Beveridge Report, para. 20. EU-China / 8

9 more detail at the technical means by which member states support social insurance expenditure. Again we will see that countries adopt a range of different approaches. As set out in the terms of reference, these can basically be summarised into four approaches: 1) Pre-subsidising social funds 2) Post-subsidising the deficit (if any) arising 3) Subsiding a minimum benefit/pension 8 4) Funding transitional costs, e.g. where there is a reform of the pensions system. We look in more detail below at these different measures but we should first point out that countries use a mix of these different policies measures. In addition, while we have categorised thee different approaches under these four headings, in practice there may not be much difference between, for examples, countries which pre-subsidise a certain proportion of a social insurance fund s annual expenditure (e.g. Japan) and a country which post-subsidises any annual deficit arising (e.g. UK). Countries often combine a variety of approaches. For example, in relation to pensions, Germany provides a general Federal State subsidy for statutory pensions which varies according to the development of the gross salary and wages per employee and the contribution rate. Germany also provides targeted pre-subsidies, for example, by paying contributions during child-raising periods. It also provides some transitional funding in relation to pensions costs arising from the unification of Germany. All the federal expenses mentioned (almost one third of the total expenses in statutory pension insurance) are tax financed. Pre-subsidising social funds A wide range of different approaches are adopted in ex-ante subsidisation of social insurance funds. In general, countries provide subsidies for specific groups, e.g. low paid workers or people taking up employment (to encourage the creation of employment); and to parents to assist such persons (especially mothers) to qualify for benefits given that statistically women generally have lower contribution records than men (largely due to parental responsibilities). In theory, countries might pay a more general subsidy to pay a proportion of social contributions which would otherwise have to be paid to the employers and/or employees. However, this is more often done by way of post-deficit subsidy (see below). Alternatively, a number of countries reduce contributions below a level which would be actuarially necessary to meet projected costs. The rationale for this may be to avoid high contribution levels so as to encourage employment or for more pragmatic political reasons that, in many countries, there is resistance to high levels of social contributions. 8 In some cases, as in Sweden, these pensions are residence based non-contributory pensions rather than social insurance pensions. Nonetheless, they also closely linked to the social insurance system and it seems appropriate to take them into account. EU-China / 9

10 Subsidies to specific groups One example of this approach (albeit not one to be recommended) is in Bulgaria where the state budget pays contributions on behalf of state employees including civil servants and soldiers. Examples of subsidies focussed on people who need support to take up employment include: Bulgaria where the State Budget covers 50% of the contributions paid for people with disabilities working for certain employers, i.e. specialised enterprises, associations of people with disabilities and. units for occupational therapy of disabled persons set up in specialised social care institutions. Romania: Contributions for unemployed persons participating in training are paid from the unemployment insurance budget. Examples of support to parents include Germany: the State pays contributions for pension insurance during child-raising periods. Slovakia: the state contributions on behalf of persons taking care of children up to the age of 6 (up to the age of 18 whose health status is considered negative in the long-term) An alternative to this pre-subsidisation approach is that some countries chose to post-fund specific schemes such as maternity (see below). It should be noted that, rather than providing direct subsidies, many EU countries have chosen to reduce contributions for specific groups (e.g. low paid workers or unemployed people). Insofar as this does not affect entitlement to benefits, this involves an indirect subsidy, either from other contributors or, where a scheme deficit is funded by the state, from the public purse. General subsidies A limited number of countries provide general subsidies of social contributions. For example, Luxembourg pays 40% of the contributions to sickness and maternity; and one-third of contributions to old age and other long-term pensions. Post-subsidising Deficit A number of countries subsidise any deficit arising in the social insurance fund. In the context of PAYG schemes, this means that the public finances are obliged to meet an annual deficit where the outgoings (benefit payments and administrative expenses, etc.) are less than the income to the fund (mainly social contributions) and any balance in the fund. Again there is variation in this approaches. In some countries, e.g. Ireland and the UK, there is a general responsibility to subsidise deficits across all (or almost all) social protection schemes. In other countries, the public EU-China / 10

11 finances fund only deficits in specific schemes. These differences are largely for historical reasons rather than having a clear policy rationale. On the basis of the information provided in MISSOC and elsewhere, these type of provisions can be found in Austria (invalidity and old age/survivors pensions; unemployment benefits); Belgium (sickness benefits); Bulgaria (pensions); Germany (state loan covers possible deficits of the federal unemployment scheme; pensions); Hungary (except unemployment); Ireland; Poland; Romania (only in the case of unemployment benefits); Slovakia (occupational accidents, invalidity and old age pensions, unemployment) and the UK. 9 Targeted Some countries chose to fund a proportion of the expenses of specific schemes such as maternity. An example is in Austria where 70% of the expenses of maternity benefit are reimbursed by the families compensation fund. Similarly in Slovenia, the state finances the bulk of the maternity benefit costs (92%) with only 8% being funded from contributions. Subsiding a minimum benefit/pension In these cases, the State pays the cost of a minimum benefit or pension level. This type of approach is found, in particular, in the Nordic countries and ensures that the costs of a minimum payment fall on taxpayers generally rather than on individual insured persons and their employers. Examples include: Finland: the state pays the costs of minimum sickness allowances and of the guaranteed old age pension Spain: the state finances the guaranteed minimum pension amount of the contributory pension system Sweden: The state funds the guarantee pension. Those who have not earned any national income-based pension at all receive a full guarantee pension. To those who receive a low income-based pension, the guarantee pension is a top-up. 10 The intention of the guaranteed or minimum pension is generally to provide a basic level of income. This approach can be seen as involving an ex post individual transfer in contrast to the ex ante transfer involved in subsiding contributions. 9 In the case of the UK, there are very limited exceptions in relation to sickness benefits, Statutory Maternity Pay, Statutory Paternity Pay, and Statutory Adoption Pay where the state meets some or most of the costs. 10 The Swedish guarantee pension is a non-contributory pension but forms part of a social insurance-based pensions system. Almost half (42%) of all pensioners currently receive a guarantee pension and, therefore, it seems appropriate to take it into account here. EU-China / 11

12 Funding transitional costs The issue of funding transitional costs should perhaps be seen separately to the above examples of pre and post-subsidisation. In theory the above examples are on an ongoing basis while funding of transition costs is to address a once-off issue (even though in practice the transition period may run over many years). Countries which use pre or post subsidisation (or which chose not to subsidise social insurance generally) may or may not decide to fund transition costs. Examples of the state funding transition costs include in Germany where the state funded costs arising from pensions reforms associated with the unification of the country and in a number of eastern European countries where the costs of pensions reform after the fall of the Soviet Union were also funded from general taxation (PRAXIS, 2008). Reserve Funds It should be noted here that a number of EU countries have created reserve funds with a view to putting aside resources in order to fund future projected pension deficits. In some cases, such as the Spanish Social Security Reserve Fund, these were made up of surpluses from social security contributions. However, in others such as the Irish National Pension Reserve Fund, the state agreed to put aside a proportion of national income. The Exchequer contributed an amount equal to 1% of GNP annually into the NPRF. The investment mandate required the Fund to secure the optimal total financial return provided the level of risk was acceptable to the Commission. The Commission implemented its investment strategy through a globally diversified portfolio that included quoted equities, bonds, property, private equity, commodities and absolute return funds. The objective of the fund was to meet as much as possible of the costs of social welfare and public service pensions from 2025 until at least Sweden also established a series of national pension funds (Severinson and Stewart, 2012). Japan and Korea and a number of other OECD countries have also established similar funds. The 2008 recession had a negative impact on the reserves of some such funds and much of the Spanish fund (which at one time contained EURO66 billion) has now been drawn down while the Irish fund has been transformed into a broader Strategic Investment Fund. However, the Swedish funds play a continuing role in the Swedish pensions system. France (which has the largest social security debt of any EU country) has established a specific fund (the Social Security Debt Fund - CADES) to repay the social debt, i.e. the accumulated deficits of the social security organizations. This is funded by a specific tax (the Social Debt Repayment Contribution) and other sources of income including other transfers from the public finances. The task of CADES is to pay down the accumulated debt by 2025 (extended from 2009). The approach adopted includes transforming ongoing short-term debt into longer-term debt and adopting a phased plan for amortizing this debt by Available data on EU states social security debt is outlined in Table A1. EU-China / 12

13 Discussion The issue raised by MoF is a very interesting one and it is perhaps surprising that there is very limited international literature on the topic. Insofar as issues concerning public subsidies for social insurance have been considered, they have tended to be considered separately. In relation to presubsidies, for example, the World Bank (2013) recently published a report on the effectiveness of matching contributions (although this looks mainly at defined contribution pensions schemes). This covers a wide range of countries including Germany, UK (and also China). Similarly, there have been some evaluations (e.g. Turkey, Korea) of the effectiveness of subsiding social insurance contributions to support employment. The conclusions of these studies are discussed below. However, there do not seem to be international studies of the effectiveness of pre-subsiding social insurance schemes more generally. Not do there appear to be such studies of post-subsidisation. Data is also lacking at EU level as to the extent to which individual countries fund social insurance from contributions as opposed to subsidies. While ESSPROS makes available extensive data (discussed above) as to the overall funding of social protection schemes, this includes noninsurance benefits and data is not readily available as to social insurance schemes separately. While MISSOC provides information on the approaches adopted by member states this is descriptive only and does not provide any quantitative data. To establish the extent to which specific member states subsidise their social insurance schemes from contribution as opposed to taxes would require an original analysis of the data provided to ESSPROS by member states and/or an examination of national data. However, some general impression can be obtained from the data provided by ESSPROS if we look only at those countries which (like China) rely mainly on social insurance. Table 1 below sets out the seven larger member states (Belgium, Bulgaria, Czech Republic, Finland, Hungary, Romania and Sweden) 12 which rely mainly (95% or more of total spending) on non-means-tested benefit (mainly social insurance) and also provides data on the extent to which these member states fund their systems from different sources Four of these countries are also shown in the OECD SOCX data as spending 6% or less of total cash expenditure on means-tested benefits (OECD, 2014). Bulgaria and Romania are not members of OECD and so no data is available from this source. 13 We do not include Denmark where the non-means tested benefits are not social insurance based. EU-China / 13

14 Table 1: Sources of funding in social insurance countries Country % non-means tested % funded by contributions % funded by general government contribution Belgium Bulgaria Czech Republic Finland Hungary Romania Sweden Source: Data for % non-means tested is from SPC (2015) while data for the breakdown between different sources is from ESSPROS (2015). 14 As can be seen, countries again take different approaches. The Czech Republic relies most heavily on social insurance contributions (over 70%) with general government contributions providing the lowest level of support - although still significant at over one-quarter of total social protection expenditure. In contrast, Bulgaria, Finland, Romania and Sweden (countries with very different welfare state models) adopt similar approaches to funding social protection. All fund about 50% from general government contributions. Belgium and Hungary are median cases with over one third of receipts coming from general government. Data are available for six of these countries over time (excluding Bulgaria). Further details on the systems in these countries are set out in Annex 1 (based on MISSOC). 14 The combination of social insurance contributions and general government contributions does not add up precisely to 100% and in most countries some small proportion of receipts come from other sources such as income from investments. EU-China / 14

15 Table 2: Trends over time in funding Country % non-means tested % funded by general government contribution Belgium Czech Republic Finland Hungary Romania Sweden Source: as table 1. As can be seen, over the period from 2000 to 2011, there has been a general increase in reliance on non-mean tested benefits (or, conversely, a decline in reliance on means tested payments). 15 The trend for these countries is different to that of the average for EU members overall where there was no real change in the period. Similarly there has been a general increase in the proportion of expenditure coming from general government contributions and conversely a fall in the proportion coming from social insurance. This was particularly marked in Romania. Most of this increase occurred in the period before 2008 (see Table A2 which also shows trends over a longer period for the countries for which this is available). This is line with trends for the average for EU countries overall where there has been increased reliance on general government contributions in the period from 2000 to Studies and evaluations Subsidising contributions The World Bank (2013) study on matching contributions (though mainly looking at defined contribution schemes) found that there is evidence that directly subsidising contributions does lead to an increase in participation in pension schemes. A study of subsided contributions for farmers and fishermen in the Korean defined benefit system (one of the few available) comes to the same conclusion (Moon, 2013). In order to encourage compliance with its national pension 15 Belgium is the only exception. 16 Receipts from general government contributions increased for EU15 from 35.8% in 2000 to 40.9% in 2014 (latest data). EU-China / 15

16 program, the government of the Republic of Korea has been providing matching subsidies to farmers and fishers of up to half of their contribution since Statistical analysis found that subsidised groups were more than 10 percentage points more likely to contribute than other selfemployed workers, after controlling for other variables, and that differences in contribution rates were larger among low-income workers. In Korea, the effect of subsidisation on reducing informality was found to be modestly positive. Of course, these conclusions depend on the design of the scheme and of the subsidy. There have been a number of evaluations of subsidisation of social insurance contributions from a labour market perspective. However, given the number of reforms in EU countries, there have been surprisingly few evaluations looking specifically at subsidisation or reductions in social contributions per se. The studies which have been carried out in EU countries have generally found limited impacts. 17 For example, reductions of payroll taxes in regional support areas in the Nordic countries have been examined in a number of studies. However, none of the studies finds any evidence that employment increased in the target regions as a consequence of the payroll tax cuts (Skedinger, 2014). Egebark and Kaunitz (2013) examined the impact of reforms to Swedish employers contributions for young people in 2007 and 2009, which reduced contribution rates by around 16% and found a small positive effect on employment. Skedinger (2014) looking at the same reforms only in the retail industry also found (at best) a modest increase in employment and concluded that reducing payroll taxes is a costly means of improving employment prospects for the young. Outside the EU, Betcherman et al. (2010) examined employment subsidy schemes in Turkey which, inter alia, subsidized employers' social security contributions. The study found that the schemes led to significant net increases in registered jobs (5% 15%). However, the cost of the actual job creation was high because of substantial deadweight losses, i.e. the number of jobs that would have been created independently of the subsidy programs.. The study suggested that the main effect of subsidies was to increase social security registration of firms and workers rather than increasing employment and economic activity. The authors concluded that the study supports the theory that in countries with weak enforcement institutions, high labor taxes on lowwage workers may lead to substantial incentives for firms and workers to operate informally. Balkan et al. (2016) looking at a similar scheme found that the subsidy program seems to be ineffective in increasing the employment probabilities of the target group but that the program has been notably effective on some sub-groups, in particular, older women. Similarly, looking at a study of social security contribution subsidies in Korea, Kim (2016; 2017) found that the subsidies increased employment by about 1% and that there were again significant deadweight losses. The author attributed this poor outcome to poor design features of the subsidy program. Kim concluded that subsidizing social security contributions may not be an effective policy tool for closing coverage gaps in countries with weak enforcement institutions. 17 See Marx (2001) for a review of earlier studies which found that employment effects of such measures were limited mainly due to larger than expected deadweight losses and, to a lesser extent, substitution effects. EU-China / 16

17 Minimum pensions The World Bank (2013) study also compared matching contributions (i.e. an ex ante subsidy) with the ex post subsidy invoked in a minimum pension guarantee (as in Sweden). This should be read with some caution as it is based on assumption rather than actual evaluation of either system. The study suggest that subsiding a minimum pension is very effective in terms of redistribution of income but not fiscally efficient as it may go to persons who do not need it. 18 In Sweden, however, the guarantee pension is reduced based on other pension income so this may not be such an issue. In any case, since these minimum pensions generally form an integral part of an overall pension system, it would be difficult to evaluate one aspect in isolation from the overall performance of the national pensions system. Subsidising deficits There do not appear to be any comparative studies of the impact (positive or negative) of subsidising fund deficits. In general, the objectives behind such an approach are obscure and, in many cases, lost in the mists of time. It is, therefore, difficult to assess how effective or efficient this approach is. If we look at the available information from MISSOC and ESSPROS as to countries which do deficit subsidise (although these sources do not provide data on the extent of such a subsidy) and data on expenditure level we do not find any clear pattern. Based on MISSOC, a range of countries provide deficit funding for more than one branch of social security including Austria (invalidity and old age pensions; unemployment benefits); Hungary (except unemployment); Ireland; Germany (pensions, unemployment); Poland; Slovakia (occupational accidents, invalidity and old age pensions, unemployment) and the UK. In table 3, we look at expenditure trends in these countries in comparison with the overall average for the EU. 18 This reflects the Bank s usual preference for means-tested minimum pensions. EU-China / 17

18 Table 3: Expenditure trends in deficit funding countries, (% of GDP) Country European Union (25 countries) European Union (15 countries) Ireland Germany Hungary Austria Poland Slovakia United Kingdom Average expenditure in the EU increased by about 14-15%. In Germany, Hungary, Poland and Slovakia expenditure remained broadly static (-3% to +1%); in Austria it increased more slowly than the average; Irish expenditure increased significantly as a percentage of GDP; while in the UK expenditure was in line with the average. Hungary and Slovakia (and Austria and Poland to a slightly lesser extent) rely heavily on non-means tested benefits while Ireland and the UK are at the opposite end of the social insurance means-tested spectrum. Again no clear pattern can be seen and there is nothing to suggest that deficit funding in principle has any specific impact on expenditure. However, one would need to look at detailed levels of expenditure funding and at broader socio-economic and demographic variables to explore this further. The legal responsibility to cover deficits does not necessarily correspond with actual practice. The EU Commission (2015) services have calculated that, in 2013, countries where the state was contributing directly to the costs of pensions included Bulgaria, Germany, Ireland, Greece, Spain, France, Netherlands, Finland and Sweden. 19 The level of contribution ranged from less than 1% of GDP in Sweden to over 6% in Finland (over 50% of total pensions receipts). 20 However, this does not include countries which contribute to other social insurance benefits while it would appear to cover all forms of pension including means-tested pensions. Therefore it is not a direct indicator of the level of state support to pension and social insurance funds but given that these funds make up a major component of social protection spending in many countries, it gives some indication of current practice. 19 No data was available for Belgium and the UK. The Irish support also covered other social insurance benefits. 20 See the national reports at EU-China / 18

19 Table 4: Expenditure trends in pension funding countries, (% of GDP) Country European Union (25 countries) European Union (15 countries) Bulgaria n/a 18.5 Germany Ireland Greece Spain France Netherlands Finland Sweden We can see that, for these countries (with the exception of Germany and Sweden), 21 the level of expenditure has increased more rapidly than the average for the EU (much more so in many cases). This would suggest that, rather than a high level of public subsidies leading to retrenchment of social protection spending, increases in social spending have driven the level of public subsidy. However, once again no consistent trend can be seen as Germany and Sweden have only modest increases (albeit that these countries started at the higher end of the expenditure spectrum). 21 Data is not available for Bulgaria in EU-China / 19

20 Table A1: Social security funds debt in EU states (Euro M) Country Belgium 8, ,239.6 Bulgaria Czech Republic Denmark Germany 1, ,143.2 Greece Spain 17, ,173.0 France 228, ,066.1 Italy Latvia Lithuania 3, ,894.1 Hungary Netherlands 36, ,774.0 Austria 1, ,388.5 Poland 10, ,504.0 Portugal Romania ,038.9 Slovenia Slovakia Finland 3, ,315.0 Sweden 4, ,025.8 EU-China / 20

21 Table A2: General government contributions as % of total social protection receipts in high social insurance countries, Country Belgium Czech Republic : Finland Hungary : : Romania : : Sweden : Source: MISSOC EU-China

22 Summary and Discussion Summary of approaches In this section we summarise the findings of the report and discuss the advantages and disadvantages of different approaches. In relation to the findings, the main conclusion has to be that there is a great variation in EU countries in how they finance social protection benefits. While EU countries (on average) fund a majority of social protection costs from social contributions, there is an enormous variation amongst countries with many relying heavily on general taxation. Similarly, general (average) trends in relation to the balance between social contributions and taxation hide a wide variation among EU member states. Countries which are often categorised as having into the same welfare state group (such as Denmark and Sweden) adopt quite different approaches to funding social protection. The mechanisms adopted by member states to fund social insurance benefits and pensions include: 1) Pre-subsidising social funds 2) Post-subsidising the deficit (if any) arising 3) Subsiding a minimum benefit/pension 4) Funding transitional costs, e.g. where there is a reform of the pensions system. However, once again there is little clear pattern. Many countries use a number of these methods but comparable quantitative data as to the extent to which different countries rely on different approaches is lacking. Unfortunately there is very little quantitative information as to the extent to which member states fund their social insurance schemes either on an ongoing basis or as to the debts (explicit and implicit) involved. In the previous section we looked data for the the seven larger member states (Belgium, Bulgaria, Czech Republic, Finland, Hungary, Romania and Sweden) 22 which rely mainly (95% or more of total spending) on non-means-tested benefits (mainly social insurance). We saw that these countries did not adopt one approach. The Czech Republic relied most heavily on social insurance contributions. In contrast, Bulgaria, Finland, Romania and Sweden fund about 50% of spending from general government contributions. Belgium and Hungary are median cases with over one third of receipts coming from general government. In these countries, there has been a general increase in reliance on non-mean tested benefits (or, conversely, a decline in reliance on means tested payments) over the period from This trend is different to that of the average for EU members overall where there was no real change in the period. Similarly, in these countries, there 22 Four of these countries are also shown in the OECD SOCX data as spending 6% or less of total cash expenditure on means-tested benefits (OECD, 2014). Bulgaria and Romania are not members of OECD and so no data is available from this source. EU-China

23 has been a general increase in the proportion of expenditure coming from general government contributions. The different approaches appear to have arisen largely for historical reasons and represent political and policy compromises. Perhaps surprisingly there has been little academic discussion about the pros and cons of different options. Pros and cons of different approaches Here we look first at the pros and cons of the four different options adopted to subsidise social insurance. Second, we look at the pros and cons of different sources of funding, i.e. social contributions versus different forms of taxation including income taxes, consumption taxes and capital taxes. Pros and cons of funding sources In terms of the pros and cons of different funding sources, we can look at the impact on work incentives, labour costs, risks of evasion, administrative costs, adaptability to demographic and economic changes, and distributive effects (drawing on Social Protection Committee (SPC), 2015). The SPC looked at social insurance contributions, income tax, consumption taxes (such as VAT), and capital taxes (including inheritance tax). The SPC (2013) points out that the options have different outcomes with respect to their revenue generating ability, their impact of the labour market, their sensitivity to evasion, their adaptability to demographic and socio-economic change, and their distributional implications (see Table). An assessment of the pros and cons of these options needs to look at all these factors. Previous studies by the EU (2012) have looked at the extent to which the design of the tax and benefit system can create (dis-)incentives to participate in the labour market. The research shows that the effects depend on the characteristics of the workforce and the institutional framework. Although the findings do not point to a generally positive employment effect of a shift from social contributions to consumption taxes, such reforms can have a significant positive impact on specific groups, such as low-skilled workers, single parents and second earners. Therefore, targeted measures may prove more effective to boost employment. However, the 2012 report also shows that a shift from social security contributions to consumption taxes can have unfavourable distributional effects, as consumption expenditures represent a larger share of poorer households' income. Social insurance contributions can, at least in principle, raise labour costs and create disencentives to employment. However, on the other hand, the link between contribution and benefits can create an incentive for people to work and pay contributions. Social contributions seem less suited to a universal benefit system because there are tied to labour contracts and therefore exclude people with no labour market attachment.the risk of evasion is related to the mechanisms for collecting social contributions (a topic being discussed in more detail in a separate report). However, one disadvantage of social contributions are that tend to contract in a recession as EU-China / 23

24 people lose jobs which creates a cyclical mismatch between the demand for social security and available revenues. They also do not respond easily to demographic change. As social protection expenditure are closely connected with population structures and economic conjunctures, demographic change and economic volatility can considerably affect the ability to raise revenues. In terms of distribution, this very much depends on the design of contribution system and whether there are upper and/or lower income limits beyond which no (additional) contribution are payable. In a number of EU Member States, taxes are used as a main source of social protection funding. They appear particularly appropriate for social protection schemes with universal coverage and correspond to political choices to fund certain benefits regardless of attachment to the labour market. The level of funding based on taxes is subject to annual budget decisions and arguably provides greater flexibility and overall government control over public sector financing. These sources include income, consumption and capital taxes. Like social contributions, income tax also increases labour costs and can have a disincentive effect. The risk of evasion depends on the overall effectiveness of tax collection in the country concerned. As with social contributions, income tax receipts will tend to contract in a recession and are also somewhat inflexible to demographic change. However, income tax is normally progressive in terms of income distribution. The advantages and disadvantages of consumption taxes obviously depend on the specific design and whether they are general or targeted. In general these taxes do not have a direct effect on the labour market and are neutral as to work incentives. They are also less subject to evasion. Like most taxes they will tend to contract in a recession but are less responsive than taxes more closely linked to the labour market and also can be more readily adapted to demographic change. However, the distributional impact tends to be regressive. Finally, capital taxes also do not have a direct effect on the labour market and are neutral as to work incentives. The likelihood of evasion of capital taxes will depend on the structure of tax and the effectiveness of collection. They are again likely to contract is a recession depending on the precise structure and source of taxation but are less closely linked to demographic issues. The distributional impact is likely to be positive. The SPC (2015) does not come to any conclusions as to the appropriate approach and simply notes that the range of approaches in EU countries provide a repository of experiences that can feed into a better understanding of how various, and potentially new, financing vehicles can be used to achieve different policy goals and optimise financing methods for more sustainable social protection. EU-China / 24